At first glance it is obvious that the picture on the left is clean and fresh while the picture on the right is dirty and very likely hosts disease.

But, if you look closer you will notice something else.

The water that is clean and fresh is moving while the water that is dirty and septic is not moving.

The purity of water is gradually diminished as it stands still from the growth of bacteria, algae, and other microbiological life.

Essentially it is rendered unusable while even it’s appearance is affected. It turns from clear to dark and murky with maybe even a stench or distinct odor.

On the other hand, when water is moving in and out, over and under, other elements, it is actually being cleaned and purified and as long as it continues to move in the right places among the right elements the water is kept clean and usable for long periods of time.

I bet you already knew that though. But, did you know that your money is like water?

The Velocity of Money

To explain this concept let’s start with the two pictures above and relate them to how your money works.

The dirty stagnant water represents what happens to money when it is left in a savings account or any other low yield account like certificate of deposits (CDs) or money market accounts, and even your retirement plans such as 401k and IRA accounts.

I can almost hear you saying, “No Way, this guy is full of it”.

Just stick with me for a minute.

Saving money is actually costing you money.

As inflation occurs  the purchasing power of your dollar is decreased. When once your dollar could buy a single loaf of bread because of inflation that one dollar can no longer purchase that same loaf.

Inflation has caused the production of that bread to cost more for the baker and so the cost to purchase the finished product has now increased.

“That’s normal,” you say. And, “How does that have anything to do with saving and retirement?”

When you place your money in a savings account or CD you are paid a percentage right? Typically less than once percent on savings and rates on CDs are currently less than a half percent. Simply pitiful.

Ok. Let’s say you have $10,000 in a savings account earning a generous 1%. That would yield you $100.

Now let’s factor in inflation which is at least 4% averaged per year.

That means that your $10,000 in savings lost $400 in purchasing power in the same year you earned $100 or 1%.

Let’s take this one step further and add in taxes that must be paid on the interest dividend you earned.

The tax burden for the average American worker is around 23-30% depending on the types of write offs you have.

With taxes of 23% and a loss of purchasing power of 4%; your once solid 1% $100 return has been dwindled down to an effective $73!!

This is what happens to your money when it sits or becomes stagnant. Like the water it loses its good and useful qualities and will require more effort and time on your part now that it is ruined.

Now that we understand why it’s not a good idea to keep your money stored in savings or other taxable account let’s talk about how keeping your money in motion is helping it to grow faster than inflation and taxes can erode it.

Let’s take that same $10,000 and use as a down payment to buy a 100k rental property.

The property you just bought now has a mortgage of $90,000 which is $429.67/month for 30 years.

Your tenants pay a monthly rent amount of $950 or $11,400/yr.

Now of course this is not all profit. We need to deduct our expenses for the property from the rental income. So $11,400 minus a mortgage of $5,156 equals $6,244 of profit per year.

Let’s see what kind of return that comes out to by dividing the $6,244 by your initial money down of $10,000 you would get 62.44%!

“That’s great”, you say, “but what about taxes on that?”

Well I’m certainly not an accountant but having done this for a few years on numerous properties I can tell you from experience that there are enough tax write offs or deductions for real estate held as investments that my income is usually not taxed and if it is it is very little.

So for arguments sake let’s use the same numbers even though they don’t really apply.

We have $6,244 profit minus a total 27% for taxes and inflation which is $1,685.88 and we get $4,558.12 or a 45.58% return on our money.

Verdict:

Taking that same dollar amount of $10,000 and placing it into an asset that produces MORE than inflation and taxes is a VERY good thing to do.

Now you have more money or dollars than is actually necessary to buy that same loaf of bread we talked about earlier.

Now knowing what you know; Does it make sense to keep putting your money in a savings account or money market account or any other for that matter?

I trust you will be able to make the smart and right decision.

Definition Of Velocity of Money

In general it is used to measure the economy at large but the concept can be adapted to the individual.

Investopedia puts it this way: “The rate at which money is exchanged from one transaction to another, and how much a unit of currency is used in a given period of time. Velocity of money is usually measured as a ratio of GNP to a country’s total supply of money.”

Essentially the more your money is moving into and out of profitable transactions the more return you realize on your investments. It really is that simple but the advice traditional financial planners give is to invest for the long term and save your money in sub-par investment vehicles.

The more you know the better you will be able to beat the game that is money.

Please join the conversation!

What Your Money has in Common with Water by Joe Nielsen